CHAPTER 19 Regulation and Antitrust Law

1. CHAPTER19Regulation and Antitrust Law

2. Learning Objectives • Define regulation and antitrust law • Distinguish between the public interest and capture theories of regulation • Explain how regulation affects prices, outputs, profits, and the distribution of the gains from trade between consumers and producers

3. Learning Objectives (cont.) • Explain how antitrust law has been applied in a number of landmark cases • Explain how antitrust law is used today

4. Learning Objectives • Define regulation and antitrust law • Distinguish between the public interest and capture theories of regulation • Explain how regulation affects prices, outputs, profits, and the distribution of the gains from trade between consumers and producers

5. Market Intervention • Government intervention in the monopolistic and oligopolistic markets • Regulation • Antitrust law

6. Market Intervention • Regulation • Rules administered by a government agency to influence economic activity • Antitrust Law • Laws that regulate and prohibit certain kinds of market behavior

7. Learning Objectives • Define regulation and antitrust law • Distinguish between the public interest and capture theories of regulation • Explain how regulation affects prices, outputs, profits, and the distribution of the gains from trade between consumers and producers

8. Economic Theory of Regulation • Four Factors Affecting the Demand for Regulation • Consumer surplus per buyer • Number of buyers • Producer surplus per firm • Number of firms

9. Economic Theory of Regulation • Three Factors Affecting the Supply of Regulation • Consumer surplus generated per buyer • Producer surplus generated per firm • The number of voters benefited

10. Economic Theory of Regulation • Political Equilibrium • The amount of regulation is such that no interest group finds it worthwhile to press for changes and no group of politicians finds it worthwhile to offer different regulations.

11. Economic Theory of Regulation • Political Equilibrium • Public Interest Theory • Regulations are supplied to satisfy the demand of consumers and producers to maximize total surplus • Capture Theory • Regulations are supplied to satisfy the demand of producers to maximize producer surplus--maximize economic profit.

12. Regulation and Deregulation • Numerous regulatory agencies have been developed since 1887. • Since 1977, industry has been going through a gradual process of deregulation.

13. Regulation and Deregulation • The Regulatory Process • Bureaucrats are appointed • Agencies adopt a set of practices and rules • Agency grant certification to a company • Price and Quantity Regulation

14. Regulation and Deregulation • Natural Monopoly • Industry in which one firm can supply the entire market at a lower cost than two or more firms can

15. Regulation and Deregulation • Marginal Cost Pricing Rule • Sets price equal to marginal cost • If the Firm Incurs a Loss • Price discrimination • Two-part tariff • Subsidy

16. Learning Objectives • Define regulation and antitrust law • Distinguish between the public interest and capture theories of regulation • Explain how regulation affects prices, outputs, profits, and the distribution of the gains from trade between consumers and producers

17. Natural Monopoly:Marginal Cost Pricing 30 25 Price & Cost (dollars per household per month) 20 15 ATC 10 MC D 0 2 4 6 8 10 Quantity (millions of households)

18. Natural Monopoly:Marginal Cost Pricing 30 Total surplus 25 Price & Cost (dollars per household per month) 20 Loss per household 15 ATC 10 MC D 0 2 4 6 8 10 Quantity (millions of households)

19. Regulation and Deregulation • Average Cost Pricing Rule • Sets price equal to average total cost • Firm Earns a Normal Profit

20. Natural Monopoly:Average Cost Pricing 30 25 Price & Cost (dollars per household per month) 20 15 ATC 10 MC D 0 2 4 6 8 10 Quantity (millions of households)

21. Natural Monopoly:Average Cost Pricing 30 25 Price & Cost (dollars per household per month) 20 Consumer surplus 15 ATC Producer surplus 10 MC Deadweight loss D 0 2 4 6 8 10 Quantity (millions of households)

22. Regulation and Deregulation • Capturing the Regulator • Maximizes profit

23. Natural MonopolyProfit Maximization 30 25 Price & Cost (dollars per household per month) 20 18 15 ATC 10 MC MR D 0 2 4 6 8 10 Quantity (millions of households)

24. Natural MonopolyProfit Maximization 30 Consumer surplus 25 Deadweight loss Price & Cost (dollars per household per month) 20 18 15 Economic profit ATC 10 MC MR D 0 2 4 6 8 10 Quantity (millions of households)

25. Regulation and Deregulation • How do agencies determine a regulated price? • Answer: Rate of Return Regulation

26. Regulation and Deregulation • Rate of Return Regulation • Sets price that enables the firm to earn a specific percent of return on its capital • Inflating Costs • Firms will be motivated report costs as high as possible.

27. Natural Monopoly:Inflating Costs 30 25 Price & Cost (dollars per household per month) 20 18 ATC (inflated) 15 ATC 10 MC MR D 0 2 4 6 8 10 Quantity (millions of households)

28. Natural Monopoly:Inflating Costs 30 Profit is maximized 25 Price & Cost (dollars per household per month) 20 18 ATC (inflated) 15 Economic profit ATC 10 MC MR D 0 2 4 6 8 10 Quantity (millions of households)

29. Regulation and Deregulation • Incentive Regulation Schemes • Gives a firm an incentive to operate efficiently and keep costs under control. • Public Interest of Capture? • Not completely clear which one • Price does not use the MC pricing rule

30. Rate of Return inRegulated Monopolies Electricity 3.2 6.1 Gas 3.3 8.2 Railroad 5.1 7.2 Average of above 3.9 7.2 Economy Average 6.6 5.1 Years Industry 1962–69 1970–77

31. Gains from DeregulatingNatural Monopolies Consumer Producer Total surplus surplus surplus Industry (billions of 1990 dollars) Railroads 8.5 3.2 11.7 Telecommunications 1.2 0.0 1.2 Cable television 0.8 0.0 0.8 Total 10.5 3.2 13.7

32. Regulation and Deregulation • Cartel Regulation • Place an output limit on each firm in the industry. • Prevent cheating • Regulation - Which One is Used? • Public interest • Capture theory

33. Collusive Oligopoly 50 Producer interest regulation MC 40 Price & Cost (dollars per trip) 30 Public interest regulation 20 10 D MR 0 100 200 300 400 500 Quantity (number of trips)

34. Rates of Return in Regulated Oligopolies Airlines 12.8 3.0 Trucking 13.6 8.1 Economy Average 6.6 5.1 Years Industry 1962–69 1970–77

35. Gains from Deregulating Oligopolies Consumer Producer Total surplus surplus surplus Industry (billions of 1990 dollars) Airlines 11.8 4.9 16.7 Trucking 15.4 -4.8 10.6 Total 27.2 0.1 27.3

36. Regulation and Deregulation • Making Predictions • Why were the transportation and telecommunications industries deregulated? • Economists became more confident and vocal • We can expect to see more deregulation.

37. Learning Objectives (cont.) • Explain how antitrust law has been applied in a number of landmark cases • Explain how antitrust law is used today

38. Antitrust Laws Year Name of law Passed What the law prohibits Sherman Act 1890 *Combination, trust or conspiracy to restrict interstate or international trade. * Monopolization or attempt to monopolize interstate or international trade Clayton Act 1914 * Price discrimination if the effect is to Robinson-Patman 1936 substantially lessen competition or create Amendment monopoly and if such discrimination is not Cellar-Kefauver 1950 justified by cost differences Amendment * Contracts that force other goods to be bought from same firm * Acquisition of competitors’ shares or assets * Interlocking directorships among competing firms

39. Antitrust Laws Year Name of law Passed What the law prohibits Federal Trade 1914 * Unfair methods of competition and Commission Act unfair or deceptive business practices

40. Landmark Antitrust Cases • Federal Trade Commission was established in 1914 to enforce the antitrust laws. • Rule of reason • Monopolies arising from mergers and agreements are not necessarily illegal. • Vertical and Horizontal Integration were found to be illegal

41. Landmark Antitrust Cases Case Year Verdict and consequence American Tobacco 1911 Guilty: Ordered to divest themselves of and Standard Oil Co. Large holdings in other companies: “rule of reason” enunciated--only unreasonable combinations guilty under Sherman Act. U.S. Steel Co. 1920 Not Guilty: U.S. Steel had a very large market share (near monopoly), mere size alone is not an offense”; application of the “rule of reason.” Socony-Vacuum Oil Co. 1940 Guilty: Combination was formed for purpose of price fixing; no consideration of “reasonableness” applied.

42. Landmark Antitrust Cases Case Year Verdict and consequence Alcoa 1945 Guilty: Too big--had too large a share of the market; end of “rule of reason.” General Electric, 1961 Guilty: Price-fixing conspiracy; executives Westinghouse & others fined and jailed Brown Shoe 1962 Guilty: Ownership of Kinney, a retail chain, reduced competition; ordered to sell Kinney (Brown supplied 8 percent of Kinney's shoes, and Kinney sold 2 percent of nations shoes) Von’s Grocery 1965 Guilty: Merger of two supermarkets in Los Angeles would restrain competition (the merged firm would have had 7.5 percent of the L.A. market).

43. Landmark Antitrust Cases Case Year Verdict and consequence IBM 1982 Case dismisses as being “without merit.” AT&T 1983 Agreement between AT&T and government that the company would dives t itself of all local telephone operating companies-- 80 percent of its assets.

44. Learning Objectives (cont.) • Explain how antitrust law has been applied in a number of landmark cases • Explain how antitrust law is used today

45. Landmark Antitrust Cases • Three Recent Antitrust Cases • IBM • AT&T • Microsoft

46. Landmark Antitrust Cases • Current Merger Rules • The Department of Justice uses the Herfindahl-Hirschmand (HHI) to evaluate mergers. • Less than 1,000 — competitive • 1,000 to 1,800 — moderately concentrated • challenged if merger would increase the index by 100 points • above 1,800 — concentrated market • challenged if merger would increase the index by 50 points

47. The HHI Merger Guidelines

48. Landmark Antitrust Cases • Public or Special Interest? • Original intent was to protect and pursue the public interest • However, the interest of the producer sometimes comes into play.